SEC Busts HFT Firms For "Tricking People Into Trading At Artificial Prices"

On Monday, in "High Frequency Trading: Why Now And What Happens Next" we predicted that "the high freaks are about to become the most convenient, and "misunderstood" scapegoat, for when the market finally does crash. Which means that those HFT-associated terms which very few recognize now, especially those on either side of the pro/anti-HFT debate who have very strong opinions but zero factual grasp of the matter, such as the following...

Frontrunning: needs no explanation

Subpennying: providing a "better" bid or offer in a fraction of penny to force the underlying order to move up or down.

Layering: multiple, large orders are placed passively with the goal of “pushing” the book away

Order Book Fade: lightning-fast reactions to news and order book pressure lead to disappearing liquidity

Momentum ignition: an HFT trader detects a large order targeting a percentage of volume, and front-runs it.

... will become part of the daily jargon as the anti-HFT wave sweeps through the land."

Of course, another name for "layering" is "spoofing" which is precisely the term that the SEC used today when it announced that it charged the owner of a New Jersey-based trading firm and several other defendants "in a scheme to manipulate the market through an illegal practice known as "spoofing."

The Securities and Exchange Commission said that Joseph Dondero, a co-owner of Visionary Trading LLC, as well as several other owners and a New York-based brokerage firm called Lightspeed Trading LLC will collectively pay $3 million to settle the charges.

Spoofing involves a trader placing orders without the intention of having them executed, a strategy that tricks people into buying or selling stock at artificial prices.

Reuters reported earlier this week that the FBI is also investigating the practice of spoofing more broadly in a probe into high-speed trading.

The SEC was kind enough to step away from the porn for a minute for the following soundbite:

"The fair and efficient functioning of the markets requires that prices of securities reflect genuine supply and demand," said Sanjay Wadhwa, a senior associate director of the SEC's New York regional office.

"Traders who pervert these natural forces by engaging in layering or some other form of manipulative trading invite close scrutiny from the SEC."

The SEC's case comes just days after the FBI and the Commodity Futures Trading Commission each said they were looking more broadly into the practice of spoofing, as part of a wide-ranging investigation into strategies that may be deployed by high-frequency traders.

One HFTer down, millions of vacuum tubes to go:

Dondero has agreed to settle the charges, pay more than $1.9 million, and be barred from the securities industry.

So is this getting clearer now? Yes: precisely those same "strategies" so pervasively used by HFTs, because Virtu didn't have a 99.9% successful trading history in the past four years from "providing liquidity", and which the SEC had no problems condoning as long as the market was going higher, are suddenly being frowned upon, and HFTs are starting to finally feel the wrath of the regulator. But that will be nothing compared to the wrath of the general public, which just like the CEO of BATS has zero understanding of how HFT actually works, when the upcoming market crash is blamed not on the Fed but on 25 year old math PhDs who "trade" and whose lobbying cash at the SEC no longer works now that almighty Goldman has finally turned its back on the high freaks.

And just as a reference so readers can get a sense of the "valuable services" a company like Lightspeed "Our trading software gives you access to real-time quotes and executions faster than ever before" Trading provide, here is an entry from their blog titled, "Ways to Trade the Twitter IPO."

With the huge popularity and notoriety of the name, it is unlikely that many active traders will get their hands on shares at the offering price, but is there a way to trade this stock once it opens to the public? Some are easy, others aren’t likely to be available to you, but here some potential plays.

Stay Long

The same thesis for going short also works for going long. Especially if the stock doesn’t make a huge jump at the open and appears to be slowly moving higher, going long for the day or longer could be a lucrative play. Just as the outsized volatility could work in your favor in a short position, it could also work as a long position.

No Options Available

Each exchange determines how soon options will be available on an IPO. For a stock as large and public as Twitter, it’s likely to be fast – as quick as a week but that doesn’t help you on the opening day.

If shorting and options trading aren’t practical strategies, what can you do?

Trade Related Names

The popularity of Twitter will bring more attention to the social media space and that could cause a short term move higher in those second derivative plays tied to Twitter. $FB, $LNKD, and Chinese media company $SINA are likely to see buying interest. Go long or use options. Don’t blindly throw money at these names, though. Look at the charts and see if they’re due for a bounce.

With sage advice such as this, is it any wonder the firm had to "spoof" in order to immitate Virtu's trading perfection?

As for "tricking people into buying or selling stock at artificial prices", surely Visionary Trading and Lightspeed Trader are the only cockroaches. Surely.

Goldman put their chips in betting on IEX over xchanges where HFT are allowed to front run.

THE Big Boss already switched sides....front running industry change dynamics. Once SEC and rest of goldman lobbysts go after banning HFTs through federal powers, GS will be there to profit while other brokers lose HFT revenue. THAT is the only reason B Katsuyama is even allowed to speak.

With rothchilds front running war news to fixed price retail brokers bundling orders and letting market makers in on the spread...(yes that's how they are able to give you trade at low cost) to the latest HFT front running institutional orders...the name of the game in the business of FUTURE PREDICTION has always been FRONT RUNNING

Let's play this forward. If these HFT firms start having HUGE legal fees, they will need to raise capital. Just paying the retainer on this shit will be big, and if you aggregate them together, that's a lot of money.

Will they be forced to liquidate a significant portion of the positions?

With the market having a hard time bouncing back for the first tiem in a while, and being that it is a Friday afternoon, the odds are looking like they'll be better than 50:50 that we start monday down too.

Goldman just got tired of their slice of pie getting smaller without their consent. "If we can't deciede how much pie we want to give everyone else then fuck um, shit in this one, and kill the pastry chef"

can't do it in the debt markets. "that's what gives." this isn't an SEC problem for "Governor" or "Mayor" so and so.

"If you like the burger don't ask how it got made."
This still looks like a plain and simple default to me..."as if 2008 never ended."
Sure the Government has Gone Crazy here ("shovel ready projects"...now known as "War here...and here, and here....oh, look! here as well!")

So sure..."we're shocked I tell you! Shocked!" But don't tell me these clowns haven't known since Day One they didn't understand the Freq Show. For all we know the SEC came up with the idea.

Oh, fer Crissakes! Just fine them $5,000 and send them a sternly-worded letter suggesting they should never do it again.

Then the powers that be can go about their business and tell the cameras how tough the regulation and enforcement is; that individual investors should have confidence in this squeaky-clean market we have here.

Zero hedge declares HTF is rigging the worlds markets... conspiracy theorist. Michael Lews says it... slightly less of a conspiracy theorist and possible some people may take a closer look. Now everyone is on the bandwagon and they knew it all along. Where the fuck were you this whole time. Fuck even last week or the week before? They should all burn.

if this HFT thingy is a "fraudulent conveyance" as it clearly is (demanding in effect "people's social security numbers") then you're committing a felony. a very BIG felony actually.

this doesn't sound like the purview of the SCC but the F...C....C.

Of course if the FCC refuses to enforce even the pretense of law then by definition this brings in "the other Agencies." For example...the Pentagon. Needless to say you don't want to be on the "terror watch list."

Oh my, a whole $3m. However will they come up with that amount? Can the SEC fuckers once, just once make an example of flat out arresting everyone, seizing all assets, clawing back every bit of everything, regardless, and THEN fining the fuck out of these scum personally while banning them from trading and banning them from access to computer/phones/etc? Doesn't even have to be a major player, just set an example.

Spoofing involves a trader placing orders without the intention of having them executed, a strategy that tricks people into buying or selling stock at artificial prices

Doesn't that require another HFT getting duped at the other ends for this to matter ? Computer 1 places fake order, Computer 2 detects it and acts accordingly, somehow, before Computer 2's order is executed, Computer 1 reacts accordingly.

Layering is effective against traders on any timescale, even the slowest meat-based trader.

You're watching the order book to get a feel for how the battle front line (price) is shifting. You see a bunch of large orders stacking up behind the bid (layered at many different prices). It gives you the impression that the bid-side is more solid than the ask, that there's more depth to the bid and more desire to buy than sell at current prices. This convinces you that there,s about to be a rout, a run up in prices so you hit the ask to get ahead of the move.

Normal to see this happen after a run, when the front-line has shifted and both sides of the book are consolidating around the new price. If one side over-extends, then the counter-attack can actually push back further than where the old front-line was drawn. Watching just the inside bid and ask really doesn't provide much insight into where the price is going next, instead one has to watch the active jostling of quotes deeper into the book.

Layering is an attempt to manipulate price movement by deceiving traders with big, fake orders. This is part of what I'm talking about when I say "the book is a lie". It's damn hard to find proper prices when the lion's share of the quotes in the book are FAKE.

Layering fake quotes has been going on forever, just that electronic trading takes it to a whole new level in which fake quotes are now the dominant volume of quotes. A completely broken market in which just watching the book can't tell you much (it's all a lie), instead complex quote origin and tracking realtime analysis is required to know what's real and what's not, something which is beyond the capabilities of even many "sophisticated" traders.

Just an observation: Since decimalization, the spread on volume stocks is around a couple of cents, and then lets say they steal another penny. Few here remember when it used to cost an eighth to make that same trade.

Also, consider HOW the SEC pins a firm for layering. The alleged wrong-doing here is that a firm manipulates perception of the order book by layering in big, fake quotes, in other words pretending to be a big buyer or seller with intent to push the price in a certain direction.

Nothing new here, it's been happening since trading began and is effectively the same as "talking your book". Take a long position, then stack up fake bids under the inside bid to try to manipulate traders into hitting the ask (and vice versa). Not unique to HFT.

Now how does the SEC ping a firm for layering? Well it has to prove intent to manipulate and the surefire way to do this is to compare how much powder a firm actually has to how much powder it's pretending to have via layered quotes.

What this means is that the SEC is only going to catch the small fish (as usual), because big firms with deep pockets can always just claim that their fake layering was legitimate and the SEC can't prove otherwise.

Same as it ever was. The SEC only catches small fish while the giant squids swim on by. Of course sophisticated, statistical analysis of quoting/trading behaviour could identify bogus layering by traders of ANY size, but the SEC is hardly known for its sophistication. (Nanex has shown several examples of dumb layering, likely fake, by HFT bots in the past, repeating patterns in the book with bizarre sizes).

You know someone asked me the other day about why do I go over and read at Zero Hedge when I'm a healthcare blogger:) I was amused but answered their question. This is one of the rare places where you have people that understand the power of financial math models and know "data mechanics" very well. I don't care if it's financial or health insurance, the two are connected in a lot of ways.

This article here "tricking people into trades"..do you not think you don't get tricked with health insurance models for profit? If you haven't thought about that, do it. They are in there for the money and not because they care for you. Have you not noticed how healthcare has become just as complex as markets? Think about is as there's been tons of articles out there on why health insurers keep their game complicated too, and thus so it's the same parallel. You can't win there either with trying to understand that system either and Obamacare is just bunch of broken algorithms from the government, insurers, 3rd party consultants that don't work together. Now that is unlike the markets who have part perfected to get your money but the complexity element is the same model. Keep it complex so people don't understand it.

Code is code and Nanex doing what they are doing will eventually break this open for people to start asking questions in other areas too, and that's a very good thing as the same models live outside of the market with creating a virtual world that is so damn complicated that they can play on it and make money. I have said this a few times to folks but take note of the numbers of quants being hired by health insurers, this stuff is even beyond their own actuaries to model and how many actuaries do you see that know how to write code? Maybe a rare few but actuaries work with tools created by quant models..duh? This is the level it's moved to over in health insurance and of course they are all publicly traded companies on the market, another common element.

So do you get tricked..sure every day out there and complexities drive it. You guys get that here for sure. On another topic though and worth a look though speaking of the news that drives stock trading, take a look at where that element is going. Nobody could have predicted what's going on over there with journalism, but every where you read, newspapers are looking for money, so you can now enjoy many more articles with "click bait" so they can collect their ad exposure revenue. I read the other day, the Oregonian paper, journo evaluations, partly based on how many clicks they get. Of course we are going to have good news out there for sure and it's not the journos faults as they need jobs and need to eat too, but thought I would call attention to this as not many are seeing this.

Ok here's the next deal..bot news. And it is happening out there as it's cheaper to do data base news with a bot that an write a story, and even search the web for additional content to add from other articles and use the information while at the same time avoiding plagiarism. Heck go wrangle a data base for news now, cheaper than hard news..it's scary.

Next level, what moves stock..news. Are you getting this, bot news moving bots on markets. Ok so you have a news story that comes out either by a human or a bot and the markets read the feed. Next step the news bot is programmed to also react to this news and let's say it wants to write a story or is programmed by the creator with parameters you can set on where the weight of the verbiage to be in the article ok? Now we have a new bot news article that may challenge the original article with good or bad news analytics..geez...

Are we headed for the battle of bots with news now to manipulate stocks? Very smart people out there know what they can do with computer code and models and it's above the level of what most consumers could understand..hmmm...yup let's keep this complex and fool a few more. Do you see where I am going with this new element? If left to it's own manipulators, well feeds could get really interesting and trading bots may really get confused (grin)..so want some more roller coasters out there? Here's a post I did relative to one company, Narrative Science, where I tried out their free version. I think I ticked off Forbes and Pro-Publica a little bit as they are both already using it and "don't put that out there" (grin). So the Feds are going to put all this raw data out there about what Medicare pays doctors, not in a format the average consumer can understand. See where this is going once the data scientists at the Times and other newspapers who have hired them is going to go..rev up those analytical algos, get a news story out here with plenty of ad click bait so the paper can make some needed money.

Now that I explained that element, is it any wonder Jeff Bezos, the CEO of Amazon bought the Washington Post...his stock is traded with bots:) It might be a little self defense in there too with his logic to at least know there is one news source where he has a say:) So far he seems to be promoting getting more humans in the news and that's not a bad idea at all as we like hard news versus the data stories we are all drowning in today as it's over done. Nate Silver seems to think we want all of that data news, but do we?

This is just a bot, bot, bot world is it not:) The journobot is coming and is already out there so again how will this be potentially used to drive markets..I know this is a deep topic here, but it is out there. Stingy corporations with all this cash won't throw news agencies a bone or a few dollars to keep quality news around? They should be very interested in this as those news bots will make or break their stock...lol. They probably won't take notice until the newspapers are so strapped for money that the percentage of bot news outdoes what the human journos write and then Houston we might have a problem.

In summary one new element we can add in here to trick people with what has value out there. If you missed it, I'll give this link again to a very interesting video done by physicist Sean Gourley and it's a bit depressing but does a good job with this telling us what little value we have out there with 61% of all web traffic is now bots, was 51% last year, will it be71% next year?

We are there as free labor to serve the bots as techno serfs to do the tedious surveys and other items that the bots can't do. We are free and the bots he said are about worth $100 each. It the danger of the artificial virtual worlds coming in here and messing with the real world.

We did get a warning on this too from Larry Ellison not too long ago and he's a coder from day one and said "be careful with artificial pieces of software that's smarter than you" and heck his daughter made a movie about it called HER. That company is a grinding machine creating software that gives us efficiencies like Microsoft does as well but the new element out there is not about efficiencies, they have other agenda out there. So when you get the wisdom of the old coders being worried about the world out there, well I think they both have some to say, they know the power of code and can see the complexities others are building to keep us "in the grays" as far as not knowing where virtual and real world values exist or how to tell the difference at times.